Companies use mergers and acquisitions to grow in size and profitability. That is simply consolidating with or gaining control of another company. A hostile takeover occurs when a company or group of investors attempts to acquire a publicly traded company against the wishes of its upper management.
Hostile takeovers are perfectly legal. They are described as such because the board of directors, or those in control of the company, oppose being bought out and have typically rejected a more formal offer. This is the main difference between a hostile and friendly takeover, in which both companies agree to the merger or acquisition.
How does a hostile takeover work?
A hostile takeover bid is launched after a formal negotiation or offer has been rejected.
A company might see an investment opportunity in a publicly traded company and want to gain control of it by acquisition or merger. This company is referred to as the bidder or acquirer. The company that is being potentially acquired is called the target company; the company who wants to acquire it is called the acquirer or bidder.
Typically the acquirer will send a letter to purchase a company, maybe even at a higher price (in a maneuver called a “bear hug”). When the board of directors of the target company rejects the offer, the acquirer can launch a bid for hostile takeover.
This is done by gaining enough shares in the target company to have a legal say in its management (tender offers), or by enacting a change in the board of directors itself (proxy battle). We’ll discuss the ways in which a company might execute a hostile takeover bid next.
With this takeover strategy, the bidder aims to gain a majority stake in the target company.
In a tender offer, the bidder will approach the shareholders directly with an offer to buy the company shares at a premium, or higher than the current market price to make a sale. If the current market price is $20, the tender offer might be for $25 per share. Since this can become costly for the bidder, it might take out a loan or find an outside investor to repay after the sale goes through -- these acquisitions are called a leveraged buyouts. The transaction is typically not completed unless a majority of the stockholders agree to it.
The tender offer is publicly announced, sometimes even in a newspaper, and is also disclosed to the SEC with a formal filing.
Creeping tender offer
With this variation on the tender offer, the bidder still aims to gain a majority stake in the target company. But rather than a formal offer, the bidder will simply start buying more and more shares of the target company’s stock on the open market, until it has accumulated enough shares to become the majority stakeholder. This is done gradually, hence the strategy's name.
A creeping tender offer is often cheaper to implement for the acquirer, since it is only paying the market rate for each share. It will can become a failed effort though if the bidder is not able to acquire a large enough share (a majority) of the target company.
Also known as a proxy battle, this hostile takeover method is aimed at the board of directors. The acquirer will attempt to get a proxy vote by convincing the target company’s shareholders to vote out the current board of directors and appoint new management that would favor the takeover. Typically the acquirer reaches out to the shareholders who hold large blocks of stock individually to sway their vote.
Here’s an example: Carl Icahn, who is well known for corporate raids, attempted and ultimately lost a proxy fight against Clorox, even suggesting his preferences for new management. This came after the company rejected his $10.7 billion bid and he famously sent an all-caps email to the board of directors.
Are hostile takeovers good for shareholders?
Shareholders can profit from the hostile takeover if it results from a tender offer sale, since they would make a profit from selling their shares of company stock for much more than they’re worth. On the other hand, they would no longer be holding onto an investment.
Hostile takeovers can often draw excess attention to a company and might stir up unease, upsetting the market, which could bode poorly for any stockholders.
Hostile takeover defenses
Hostile takeovers are not inevitable. Target companies can implement different measures to prevent a takeover before it begins or to deter the takeover bid from becoming a done deal.
Poison pill: Public companies can implement a shareholder rights plan to dilute the value of its stock in case someone tries to take over. The poison pill plan might issue new stocks to shareholders, or allow shareholders buy company stock at a discounted price, usually after one shareholder has purchased a certain (large) percentage of them. This will cause the value of the stock to rise, making the potential acquisition more costly to the bidder.
Golden parachute: With this takeover defense, the top directors of a company are contracted to receive a very large compensation if they’re let go due to mergers or acquisitions. This could sway the acquirer from the takeover, since they’ll have to pay out a costly severance package (often millions of dollars) to the company’s executives.
Crown jewel defense. The target company can sell off its most valuable assets to look less appealing to potential acquirers.
Pac-Man defense: The target company can go head to head with the acquiring company by mounting its own takeover bid — the target company will purchase shares of the acquirer’s stock.
Differential voting rights: If you own a share of company stock, you might be awarded quarterly or yearly dividends, or a small payout of the company’s profits. With differential voting rights, shareholders with lesser voting powers get larger dividends, incentivizing them to hold onto these shares and not give away their proxy vote. Meanwhile, the board can retain a greater block of voting powers.